Should America try industrial policy?

NOAM SCHEIBER has surveyed the economic scene in America and determined that it's kind of bleak, so far as medium-term growth prospects go. Americans remain heavily indebted, which suggests that consumption won't rebound to growth-driving levels for years. The other traditional route to a rapid growth turnaround—an export boom—would seem to be problematic as well, given the global nature of the recession. Some countries can export their way out of recession, but not everyone can. Given America's lingering trade deficit, it seems an unlikely candidate to follow the export path to recovery. So what does that leave? Here's Mr Scheiber:

So far as I can tell, the only solution to the underlying economic problem is something that's been a dirty word in Washington the last generation or two: industrial policy (that is, an active government role in the development of certain industries.) In his LSE lectures, Krugman quipped that "if someone could invent the 21-st century moral equivalent of the railroad, or actually even the moral equivalent of IT in the '90s, that would help a lot." I agree--that would help a lot. But waiting around for this to happen seems risky when the alternative is a decade of stagnation.

If, on the other hand, the government were to place some massive bets on R&D, we might substantially increase our chances of stumbling onto a major technological breakthrough--or at least accelerate the process. True, industrial policy is a lousy idea under normal circumstances: Any invention with lucrative commercial applications should have a high enough expected return to attract private capital Using government money to fund progressively longer shots is likely to be wasteful. (The exception is technology that would be socially useful but whose commercial applications aren't immediately obvious.) But, in a deep recession like this one, the case for industrial policy gets much stronger. At worst, the additional government spending would inject some needed stimulus into the economy. At best, it might yield a technological breakthrough that could attract a subsequent wave of investment and make growth self-sustaining.

One quick nitpick—it is not the case that the entire world is too indebted to consume. China has a very low ratio of debt-to-GDP. It is currently sitting on in excess of $2 trillion in foreign exchange reserves, and it continues to suppress domestic demand by pegging its currency to the dollar. As the global recession hammered Chinese exports, the government did more to free domestic spending and investment. As The Economist mentioned not long ago, investments in China's social safety net could help reduce the country's extremely high household savings rate, encouraging still greater levels of domestic consumption. China might not be able to drive global growth through consumption as America did previously, but it could do enough to make the next decade look a lot less daunting, at least where American growth is concerned.

But let's return to Mr Scheiber's main point—that the government should try and encourage the development of new industries. Essentially, he's breaking output down into constituent parts—consumption, investment, government spending, and net exports—and saying that consumption and net exports are unlikely to drive output growth, and government spending can only temporarily do the job. Therefore, the government should seek to boost investment.

Is this a good idea? I suspect that America could significantly increase the amount it invests in education, infrastructure, and basic research before diminishing returns set in. I am not so confident about money spent on specific technologies. As Mr Scheiber notes, the administration has set aside $2.4 billion in grant money for groups researching technologies related to electric vehicles. Would $20 billion more help? How many researchers are currently working on the topic, and if billions more were allocated to it, would that simply draw talent away from other promising areas of research? What are the constraints here?

A better solution might be to identify the specific goals one has in mind—reduced oil dependence or emissions, say—and use taxes to direct consumption and investment toward the most promising areas of research.

Mr Scheiber also suggests that the period about which he is worried is the next ten years or so; beyond that consumption will likely recover as debts are paid down. But what are the odds that some new and promising discovery will emerge within the next decade that can be developed quickly enough to provide large scale opportunities for employment? The government can throw trillions at research at the moment, and that will do very little for the millions of unemployed workers unqualified to develop a new generation of battery or medicine.

One might instead direct industrial policy at support for industries that are capable of employing a lot of people in a short amount of time. But how to do that while not excessively standing in the way of needed structural adjustments? If labour-intensive manufacturing in America is not sustainable over the long term, then a ten-year programme of support for such industry will simply encourage a new generation of American workers to pursue a set of skills that will prove obsolete in a decade.

While there seems to be plenty of room to increase employment efficiently by incentivising investments in the basics—education at all grade levels, deployment of new infrastructure, and basic academic research in science and engineering—industrial policy strikes me as a very poor way to boost the economy over the next decade. It would likely be ineffective over the short-term, and counterproductive over the long term.

It's worth closing with another snippet from that Economist story linked above:

The more important reason why consumption [in China] has fallen is that the share of national income going to households (as wages and investment income) has fallen, while the share of profits has risen. Workers’ share of the cake has dwindled because China’s rapid growth has generated surprisingly few jobs. Growth has been capital-intensive, focusing on heavy industries such as steel rather than more labour-intensive services. Profits (the return to capital) have outpaced wage income.

Capital-intensive production has been encouraged by low interest rates and by the fact that most state-owned firms do not pay any dividends, allowing them to reinvest all their profits. The government has also favoured manufacturing over services by holding down the exchange rate as well as by suppressing the prices of inputs such as land and energy.

Industrial policy in China has in many ways been an impediment to robust, sustainable growth, which is unfortunate for the whole of the global economy at this moment. That's a lesson Americans would do well to heed.

The US Government should probably not invest so much in industries themselves as in their basic generators: better roads and bridges, university-based research and cleaner and better streetscapes and parks. The problem with any policy that favors an industry is that that favoritism swings with governmental moods. This creates a scattershot policy. Governments should invest in that which benefits all citizens, private or corporate, rather than favored industries. There are certain incetives I don't mind, such as cleaner energy, but for the most part the end of the slipery slope is 1960s and 1970s era favoritism of businesses that care more about the politicians that favor them than the people that buy from them. This is a dance too dangerous, in my opinion.

Industrial policy presumes that the government can attain higher returns from spending the peoples' money than they can themselves, which is absurd. There is absolutely no evidence to think that government has a special aptitude to identify and promote the "next big thing" that will generate economic growth.

Well, if 'the next technological thing' is what we're after, maybe we could start by requiring our foreign-born PhD graduates to STAY instead of forcing them to leave the country with their expensive state-subsidized education...

"Krugman quipped that "if someone could invent the 21-st century moral equivalent of the railroad..."

Before you consider an industrial policy, look at Japan's use of an industrial policy and how well that has worked for them, then read "How Capitalism Saved America" by Thomas DiLorenzo. In it you'll find that every state subsidized railroad went bankrupt and the totally privately finance railroad prospered.

Why can't bureaucrats plan as well as entrepreneurs? Because bureaucrats have no skin the game. They play with other people's money. The only thing politicians get out of industrial planning is greater campaign contributions from people who stand to benefit from the state spending. As a result, railroads went through towns chosen by campaign contributors of powerful pols instead of to towns where they were needed and could be profitable. The same is true of roads and bridges. Remember Alaska's "bridge to nowhere?" That is typical planning for pols and bureaucrats.

People keep bringing up the idea of industrial policy as if no one in the world has ever tried it before. But it has been tried and tried and tried and tried for centuries and failed and failed and failed and failed. If industrial policy could work, then the USSR would still exist and China would have no free markets. How many times does it have to fail before people give up?

The state has proven for centuries that it can't do business. But it can waste people's money better than anyone.

It would be interesting to compare the German experience to the US. When they absorbed the east, which was low wage / low productivity, they decided, it seems, that their best strategy was to become a better value-added competitor. This allowed them to create wealth as exports grew and to handle the higher cost of absorption and their social welfare system. The US seems determined to compete at the low end to middle and encourages intra-US competition that sucks jobs to marginally lower cost states - that still have no chance of successfully competing with China et al on cost. Seems like we're making a strategic mistake.

Doug - do you really need to see a post that explains that consumers of oil-based fuels are not paying the full societal cost? (try venting your tailpipe into the cab to illustrate the point)
Or a post showing that we're spending hundreds of billions on military bases and misadventures in oil-rich countries?

Ahem!
But then wouldn't government investing in infrastructure (like new roads) deter the private investors to build and toll and then live like victorian english renters?!
What to do, what to do?!
Anyways, nice article.

Fundamentalist, on the flip side a lot of East Asia survives and prospers quite well (hell, even Japan continues to be rather innovative, but if not Japan, then China and the Tigers) with models rather close to industrial policy. Private enterprise is good, but I hesitate to see the world to be as simple as for private enterprise to be an end-all solution.

You are absolutely correct in your position that individual entrepreneurs have a lot more fire under their backsides (though I think that far more relevant is the fact that, unlike for major government projects, if a single entrepreneur fails no one hears or cares about it) but they are also not very well positioned for projects with very long time horizons - 50 years say.

First, because no one has the money to keep investing for 50 years without seeing returns until then. Second because few people would be motivated to personally invest anything (time, effort, money) over that time horizon as by the end of it they would be close to dead and thus unable to reap any rewards.

Since it seems unlikely to me that there exist no worthwhile long-term projects, some 'civilisation-scale' mode of investment should exist. The question then becomes whether to entrust it to current bureaucracy (typically with 4 year horizons and beholden to special interests) or try to invent something else. Whatever the case would be, it should be kept in mind that, just as with private enterprise, a lot of mistakes will be made and a lot of money wasted before a good innovative venture actually succeeds.

You can't ignore the facts merely because they don't fit your ideology. America has pitifully underinvested in a number of very important areas - and if we don't fix that we'll only have ourselves to blame for declining productivity and poor economic growth.

So, how do we overcome the problem of bureaucrats not having skin in the game? Simple: have them invest alongside those with skin the game. Many cities and states already do public-private partnerships like this. The Fed Govt could really jumpstart Clean Energy by investing along with venture capitalists.

We've subsidized Dirty Energy for far too long. It's time to be a little visionary and create a cleaner energy future.

Come on commentators on this blog - show some imagination instead of whining like babies with wet diapers.

Even though it pains to admit, in this case Doug and Fundmentalist and the rest of the rightwingers here are correct.

Industrial Policy is stupid except in some rare cases of natural resources (even an idiot knows that oil will pay).
I personally believes that one of the main reasons for the success of the Nordic countries are that we never mixed politics and business they way that continental Europe did. Politicians are just not skilled enough, even if they are driven by a true altruistic wish to do good.

But I disagree that the government can't manage schools. The best schools in the world are to my knowledge the Finnish ones, and they rather die than let a company run one. For all the heralding this paper has done for the Swedish privatizations of schools, the quality of the system has been in decline during this whole period.

"While there seems to be plenty of room to increase employment efficiently by incentivising investments in the basics—education at all grade levels, deployment of new infrastructure, and basic academic research in science and engineering..."

K-12 spending on education is a black hole. In my school district we are still uncovering the corruption - as increased taxes, when they are approved does not go to the children.
The call for more R&D seems to have been stymied by the 2010 budget (see below). Will America cede another area in which it is strong in?

William Easterly's "The Elusive Quest for Growth" has a chapter devoted to education. "Education, For What?" I believe is the chapter title. To that end, I leave you with the latest news of the Augustine Panel.

Early results of cost analysis by the Augustine human spaceflight panel have found no good options for continuing human exploration of space within the constraints set by the Obama administration's fiscal 2010 budget plan for NASA.
"This budget is simply not friendly to exploration," panel member and former astronaut Sally Ride said during the group's final public meeting in Washington Aug. 12. "It's very difficult to find an exploration scenario that fits within this very restrictive budget guidance that we've been given."

Judging the amount of the money people spent on higher education, I suspect there's a massive suppressed demand for better K-12 education too. If we can only liberate it from the dead hand of the state we'll have a thriving industry. Not public schools are bad, of course, but overall, is there a sector in our economy that's more miserable? Providers work in appalling environments for meager rewards. Consumers' needs are not satisfied. Just today I was reading about the Detroit school district. The graduation rate is 25% and the district is going bankrupt.

The government is especially ill-suited when it comes to education. Good education takes time to develop. Our great higher-ed institutions didn't just spring into existence from a bundle of cash. Good schools need not just material goods and human capital, but also social capital. Reputation and traditions are hugely important and cannot be bought. They take time and sustained investment, which fits neither the political schedule of elected officials or the boom-bust cycle of tax revenue. California might have made some progress in recent years, but now all that is turning back into dust.

aidan, How do you know that China and the Tigers didn't grow in spite of their industrial policies? And if industrial policies work in Asia, why not the West? The record of industrial policies in the West is very bad.

China has not changed its industrial policy in the past 50 years. What has changed in China is the freedom of certain sectors. Logically, one would credit the thing that changed for the change in growth rather the thing that stayed the same.

Most states in the US have constitutional clauses that prevent the state from owning businesses and the reason is very clear. Right after the civil war many states decided to invest directly in new business ventures instead of waiting for private investors to do the job. Almost every single state that ventured into business went bankrupt.

As for projects that require 50 years, first consider that new electrical generating plants require 30 years. But if a project takes 50 years to complete, then the profits on it would have to be astronomical to make it worthwhile. If the profits potential isn't that high, then maybe the project isn't really needed or wanted. Maybe some politician just wants to build a monument to himself. Of course, politicians can justify anything. That's why every year we pay billions for roads and bridges to nowhere.

I was listening to an urban planner on the radio a while back when Tulsa was building a new convention center. The expert said that no convention center in the country pays its expenses; all require substantial subsidies from the cities' general funds, which drains money needed for fire and police. Asked why politicians build those monstrosities, he could only speculate that they wanted a monument to their regime.

NO-a big NO .I think at industrial policy all and all partners concerned should be involved. What we see in China is part of the story to be neglected (by USA and EU)for sooner or later it is going to fall. The Chinese want to copy others at history but do not know yet how to do it-so crazy they are gone with their trillions( mostly on export of fake goods) ! Any success at that policy should not leave any behind in the dark-for corruptions etc etc to raise their heads(as we are witnessing in China-just adjust your lenses closer and apply H formula at the study!)